WHAT IS A MONEY MARKET?
As per RBI definitions “A market for short terms financial assets
that are close substitute for money, facilitates the exchange of
money in primary and secondary market”.
The money market is a mechanism that deals with the lending,
borrowing and trading of short term funds (less than one year)
with high liquidity and very short maturity.
It doesn’t actually deal in cash or money but deals with substitute
of cash like trade bills, promissory notes & government papers
which can be converted into cash without any loss at low
It is not a single homogeneous market, it comprises of several
submarket like call money market, acceptance market, discount
market & bill market.
The components of Money Market are the commercial banks,
acceptance houses & NBFC (Non-banking financial companies).
FUNCTIONS OF THE MONEY MARKET
Transfer of large sums of money.
Transfer from parties with surplus funds to parties with a deficit.
Allow governments to raise funds.
Help to implement monetary policy.
Determine short-term interest rates.
IMPORTANCE OF MONEY MARKETS
Development of trade & industry.
Development of capital market.
Smooth functioning of commercial banks.
Effective central bank control.
Formulation of suitable monetary policy.
Non inflationary source of finance to government.
COMPOSITION OF MONEY MARKET
Money Market consists of a number of sub- markets which collectively
constitute the money market. They are:
Treasury bill market.
Commercial bills market (or discount market).
Call Money Market.
Commercial paper market.
Certificate of deposits markets.
INSTRUMENTS OF MONEY MARKET
1. Treasury Bills (T-Bills): The Treasury bills are short-term money
market instrument that mature in a year or less than that. The
purchase price is less than the face value. They have 3-month; 6-
month and 1-year maturity periods. The security attached to the
treasury bills comes at the cost of very low returns. Treasury bills
began being issued by the Indian government in 1917.
Treasury Bills are the most marketable money market security.
They are issued with three-month, six-month and one-year
maturities.( 91- Day, 182- day, 364- day)
T-bills are purchased for a price that is less than their par (face)
value, when they mature the government pays the holder the
full par value.
T-Bills are so popular among money market instruments because
of affordability to the individual investors.
Treasury bills are highly liquid because there cannot be a better
guarantee of repayment then the one given by the government
and because the central bank of country is always willing to
purchase or discount them
Sample: Treasury bill in Francs 1923, used internally at the Treasury signed Fisher.
2. Certificate Of Deposit: The certificates of deposit are basically
time deposits that are issued by the commercial banks and
financial institutions. The bearer of a certificate of deposit
receives interest. The maturity date, fixed rate of interest and a
fixed value - are the three components of a certificate of
deposit. It was in 1989 that the certificate of deposit was first
brought into the Indian money market.
A CD is a time deposit with a bank.
Like most time deposit, funds cannot be withdrawn before
maturity without paying a penalty.
The main advantage of CD is their safety.
Anyone can earn more than a saving account interest.
Sample: A certificate of deposit issued by Barclays Bank.
3. Commercial Papers: Commercial Paper is short-term loan that is
issued by a corporation use for financing accounts receivable and
inventories. Commercial Papers have higher denominations as
compared to the Treasury Bills and the Certificate of Deposit. The
maturity period of Commercial Papers is a maximum of 9 months.
Issued by a corporation typically for financing day to day
Very safe investment because the financial situation of a company
can easily be predicted over a few months.
Only company with high credit rating issues CP’s.
Advantages of commercial paper:
High credit ratings fetch a lower cost of capital.
Wide range of maturity provides more flexibility.
It does not create any lien on asset of the company.
Tradability of Commercial Paper provides investors with exit
Disadvantages of commercial paper:
Its usage is limited to only blue chip companies.
Issuances of Commercial Paper bring down the bank credit limits.
A high degree of control is exercised on issue of Commercial
Stand-by credit may become necessary
4. Commercial Bills: It enhances he liability to make payment in a
fixed date when goods are bought on credit through a short term,
negotiable, and self-liquidating instrument with low risk.
It may be a demand bill or a usance bill. A demand bill is payable
on demand, that is immediately at sight or on presentation by the
drawee. A usance bill is payable after a specified time.
BILL OF EXCHANGE - The financial instrument which is traded in
the bill market of exchange. It is used for financing a transaction
in goods that takes some time to complete.
It shows the liquidity to make the payment on a fixed date when
goods are bought on credit.
Accordingly to the Indian Negotiable Instruments Act, 1881, it is a
written instrument containing as unconditional order, signed by
the maker, directing a certain person to pay a certain sum of
money only to, or to the order of, a certain person, or to the
bearer of the instrument.
INLAND BILL – Must be drawn or made in India, and must be
payable in India. It must be drawn upon any person resident in
FOREIGN BILLS - Drawn outside India and may be payable in and
by a party outside India, or may be payable in India or drawn on a
party resident in India. Examples include import and export bills.
Specimen of a bill of exchange.
5. Repo Instrument: The Repo or the repurchase agreement is used
by the government security holder when he sells the security to a
lender and promises to repurchase from him overnight. Repo
transactions are allowed only among RBI-approved securities like
state and central government securities, T-bills, PSU bonds, FI
bonds and corporate bonds.
Repo is a form of overnight borrowing and is used by those who
deal in government securities.
They are usually very short term repurchases agreement, from
overnight to 30 days of more.
The short term maturity and government backing usually mean
that Repos provide lenders with extremely low risk.
A reverse repo is simply the same repurchase agreement from the
buyer's viewpoint, not the seller's. So "repo" and "reverse repo"
are exactly the same kind of transaction, just being described
from opposite viewpoints.
The repo rate in India as of 18th Feb '13 was 7.75% and the
reverse repo rate which is 100 bps below the repo rate stood at
6. Banker Acceptance: It is a short-term credit investment. It is
guaranteed by a bank to make payments. The Banker's
Acceptance is traded in the Secondary market. 90 days is the
usual term for these instruments. The term for these instruments
can also vary between 30 and 180 days.
A banker’s acceptance is a short-term credit investment created
by a non-financial firm.
BA’s are guaranteed by a bank to make payment.
Acceptances are traded at discounts from face value in the
BA acts as a negotiable time draft for financing imports, exports or
other transactions in goods.
The party that holds the banker's acceptance may keep the
acceptance until it matures, and thereby allow the bank to make
the promised payment, or it may sell the acceptance at a discount
today to any party willing to wait for the face value payment of
the deposit on the maturity date.
7. Call money: It is a short term finance repayable on demand,
with maturity period of one day to fifteen days, used for inter-
bank transactions. Commercial banks have to maintain a
minimum cash balance known as cash reserve ratio. The Reserve
Bank of India changes the cash ratio from time to time which in
turn affects the amount of funds available to be given as loans by
commercial banks. Call money is a method by which banks lend
from each other to be able to maintain the cash reserve ratio.
Part of the national money market where the day to day surplus
funds, mostly of banks are traded in.
They are highly liquid, their liquidity being exceed only by cash.
Banks borrow from other banks in order to meet a sudden
demand for funds, large payments, large remittances, and to
maintain cash or liquidity with the RBI.
Call rate - The rate of interest paid on call loans is known as call
rate. Call rate is highly variable from day to day, often from hour
to hour. It is very sensitive to changes in demand for and supply of